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‘Big Data’ Generates Big Returns: Q&A With VC Roger Ehrenberg

“Big data” investment is accelerating in the world of venture capitalists and the tech startups they are funding. The big data theme has attracted nearly $5 billion of funding over the past five years, according to the VC database CB Insights; 2012 was the biggest year of deals so far, seeing 19.5% growth from the previous year.

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Roger Ehrenberg, founder of venture capital firm IA Ventures, has harnessed this admittedly “fruit of the day” moment by raising money to invest in startups solely around a big data theme. He has raised $155 million to back early-stage startups, partnering with entrepreneurs to help build their businesses from the beginning. He then takes a real hands-on approach in helping to develop the companies, something he says many VCs used to do and then got away from.

Ehrenberg sat down with Yahoo!Finance for a fireside chat at South by Southwest (SXSW) in Austin on Saturday. Here are some highlights.

What does "big data" mean? (Ehrenberg has been quoted as saying the term has become so beloved by the media that it has gone from “hackneyed” to “worthless.”)

I do think it’s a stupid term. But I break it down as enabling technologies in platforms and applications that by themselves create unique defensible data assets...I would say an example would be a company like Simple, a retail bank optimized for your mobile device. They collect all kinds of interesting information from where and when you swipe your Simple card...They know so much about you that’s not inferred, it’s actual because people are doing real transactions, using a Simple card in lieu of a credit card.

(Disclosure: IA Ventures is an investor in Simple.)

What do you look for in the companies you invest in and partner with?

We initiate positions generally at the seed or very early “A” stage, so it’s heavily an investment in a team, a product vision and a market, in that order...It’s how you feel you would work with them, because as a company, especially at that stage, you’re partners. When I don’t have that visceral connection with the team -- not that they’re not qualified, but something’s just not right in the gut -- you just have to follow it. A great market can’t compensate for mediocre execution.

What’s your advice to entrepreneurs, particularly in this space, who want to attract VC funding?

As early as you can, engage with real customers, even if your product totally sucks. What I see, especially in this space, it tends to draw brainy people but [it's] not necessarily the most people-oriented, so entrepreneurs develop something cool that not that many people want. But had they engaged with these uncomfortable discussions with customers early on and were open to sharing what they had built early on, and then incorporated their feedback into the product roadmap. It’s where a tech founder also has to be a product manager. Customer engagement as early as possible is the single biggest piece of advice. And have a co-founder. It’s unbelievably difficult to build a company, even in early days, on your own, where you don't have a foil to get you outside of your head.

There have been more entrants into VC over the past five to six years, adding more competition to an already competitive field: Is the market overpaying for the “hot” startups and why?

There are actually fewer firms but a huge increase in the number of firms and individuals doing seed-stage financing. In that environment, it’s certainly good for the founders, depending on what they’re optimizing for. We will not get in those pissing contests with other firms. We are firm in our resolve that a team needs to wants us as much as we want them. But a lot of these companies are getting financed at levels that will ultimately hurt the founder unless they execute perfectly, because they have no margin for error.

Is Foursquare an example? The Wall Street Journal reported they raised money in a deal that valued the company at $760 million. Later they had trouble going out and raising money again at that valuation after the botched Facebook IPO.

There are many cases of companies raising money too expensively, where founders felt great at the time, but it removed a whole layer of optionality either for an exit or taking additional capital. I think it’s doing a real disservice for entrepreneurs. And there’s this echo chamber and alternate reality we’re living in, where, sure there’s Airbnb and Dropbox, and that’s great. But do you know how many Airbnb and Dropboxes there are? Two.

Looking at three big IPOs for VC: Facebook (FB), Groupon (GRPN), Zynga (ZNGA). Why is it they delivered historic returns for venture investors but were blowups for the public in terms of the stock?

I think what we saw was a massive disparity between private market value and public market value. Some of those private rounds in the go-go companies, for example prior to Facebook’s coming out, were so inflated when they started out in the public market, and then conventional institutional investors started to analyze their financials, analyze prospects, look at risks, [and they said 'wait a minute']. That notion of private capital bridging the gap between the last leg of growth prior to going public, cashing out a bunch of early investors and founders, is a dangerous game.

Is it a game that’s still going on?

It’s still happening but at more rational prices, which is healthy, because Facebook should not be looked upon as a failure.

For investors in VC funds, there have been some big winners where, if you were invested in the right fund, you made eight to 12 times your money. But on aggregate returns, they have not been great. Why?

Because firms have taken in way too much money...In an IPO environment like the one we have today. It’s just not there[to get the kind of return on capital you need.]

According to PEHub, VC funds are having a hard time raising money so far this year. But it names your fund as one of the handful of areas money has gone. How have you bucked the trend?

I was one of very earliest to identify [big data] as an investable theme. It’s not like I cracked the atom -- every firm has invested in these kinds of companies for a long time. But for me to say "I’m going to build a firm with this unifying principle and I’m building a team uniquely suited to prosecute this mission and give hands-on support to our founders," it really resounded with investors.

What are the big-data trends on the horizon?

It’s a difficult question. One area that’s particularly interesting is reshaping manufacturing. Why would an IT-oriented invest firm want to get involved in that? A lot of the innovation that’s happened has not filtered down to the shop floor. They have these proprietary systems that are disgustingly expensive, very inflexible, and that they’re shackled to. Eventually that has to change because of the trend toward serialization. And you think of industries like bio-tech -- you screw up there, you kill people. That, to me, is a really interesting but difficult area.

Cyber[security] is scorching hot right now, especially with the infiltration of mobile. There are some great companies in that space, but a lot more innovation to happen.

Meanwhile, Wall Street and also government have been using big data for awhile. What trends are you seeing there?

Wall Street, as with government, has been leveraging big data technologies for decades. However, the massive increase in the amount and complexity of data has rendered legacy Wall Street infrastructures outmoded and inadequate. For example, while Goldman has been working with private clouds for years and has long viewed their data asset as a source of competitive advantage, most other firms are well behind. And with the increasing stress on risk management and real-time information about exposures spanning the globe, Wall Street firms are going to have to take some big chances in re-shaping their technical architecture to support a holistic approach to data management and the extraction of real-time insights.

And for just the average person or consumer, is privacy essentially dead? And if so, is there any silver lining to make ordinary people feel better about that?

I believe consumer privacy is largely dead, and that there is an implicit pact between the consumer, retail providers and the government. It goes like this: "Give me the best experience possible on whatever device I'm using, where I only see contextually relevant recommendations and receive appropriate offers. Also, please keep me safe by hunting down the bad guys who are hacking into my service providers' databases that hold my confidential data." There is no easy answer, but I do believe that the privacy horse left the barn a long time ago.

WALL STREET, AS WITH GOVERNMENT, HAS BEEN LEVERAGING BIG DATA TECHNOLOGIES FOR DECADES. HOWEVER, THE MASSIVE INCREASE IN THE AMOUNT AND COMPLEXITY OF DATA HAS RENDERED LEGACY WALL STREET INFRASTRUCTURES OUTMODED AND INADEQUATE. FOR EXAMPLE, WHILE GOLDMAN HAS BEEN WORKING WITH PRIVATE CLOUDS FOR YEARS AND HAS LONG VIEWED THEIR DATA ASSET AS A SOURCE OF COMPETITIVE ADVANTAGE, MOST OTHER FIRMS ARE WELL BEHIND. AND WITH THE INCREASING STRESS ON RISK MANAGEMENT AND REAL-TIME INFORMATION ABOUT EXPOSURES SPANNING THE GLOBE, WALL STREET FIRMS ARE GOING TO HAVE TO TAKE SOME BIG CHANCES IN RE-SHAPING THEIR TECHNICAL ARCHITECTURE TO SUPPORT A HOLISTIC APPROACH TO DATA MANAGEMENT AND THE EXTRACTION OF REAL-TIME INSIGHTS...